The Free Market Optimist

After Earth Day: Capitalist Ideas Save the Planet

Part II in a series on how capitalism will save the environment. Read PART I here.

(In EARTH DAY SHOCKER!! CAPITALISM SAVES THE PLANET! I examined how in 2015 we passed a tipping point where big solar and wind have started to become cheaper than gas or coal, unsubsidized. Here, by way of a Part II, I examine the policy implications of that shift, and how it could create shockingly positive capitalist future.)

Last Earth Day world leaders gathered to sign a global climate accord, offering ambitious emission pledges — more aspirational that substantive — that leave wide open the question of how all this will actually be accomplished.

Fortunately, clean capitalists lead the way. Crushing costs, big wind and solar just beat gas or coal on unsubsidized price alone, with lowest levelized costs for best executed and sited plants in 2015.[1] The strong forecast-beating trend is clear: surging growth, profitability and competitiveness are here now, at the leading edge, with more on the way.

The most stunning implication of this market disruption? When unsubsidized profits appear in industries with strong tech driven cost reduction curves, tax rates on profits suddenly matter, a lot. These can have a strong effect on growth by boosting returns, thus attracting new investment. So suddenly tax rates become a powerful policy tool. One as yet unconsidered by most climate policy experts or economists or world leaders.[2]

In fact, we now have a whole NEW set of policy options to consider. Well, not new, actually… rather, traditional pro-capitalist policy options, such as: marginal tax rate cuts on investments, spending cuts, phasing out of bad policy, deregulation, individual and entrepreneurial empowerment; extending third world property rights to curb poverty, deforestation, and the toxic devastation of illegal mining; promotion of choice, competition, and positive side laissez-faire.

And by the way, all this likely applies to more than just wind and solar. Many areas of clean tech are now mature profitable industries. Hydro, geothermal, hybrid and plug-in hybrid vehicles, LED lighting, a whole universe of energy efficiency entrepreneurship, all these and more have shown profits and long-term viability. Other sectors, such as smart grids, regenerative forestry and agriculture, electric vehicles, power storage and batteries, alternative renewables, all show potential, some with steep cost reduction learning curves similar to big wind and solar, indicating they are on the same road to competitive viability. The same set of pro-capitalist policies likely can accelerate all of these clean tech industries while delivering the same boost to GDP.[3]

Few of the experts at IPCC, IEA or USEIA, or most anywhere else, foresaw these traditional free market policy options would now apply, and could help reduce climate change.

But they do. And the most powerful and cost effective of these pro-capitalist policies, paving the way for all the others, will clearly be marginal tax rate cuts on investments in clean tech (a.k.a., clean tech tax rate cuts[4]). Why? Because, logically, we already know it can work better than existing policies.

If you want more of something, tax it less. That’s a basic concept from Economics 101. We know it works. So for example, if you want more prosperity, cut tax rates on profits. And if you want more ever-cheaper green energy and clean tech, simply cut tax rates for such investments. It is the simplest, most direct, most economically beneficial way to accomplish that objective. With the huge multiple benefits of reducing CO2 and other pollution and health risks while boosting prosperity and lowering energy costs.

Lower marginal tax rates on rising clean tech profits (i.e., corporate, dividend and capital gains tax rate cuts) would boost return on investment, inducing investors to pour additional billions into the sector. That accelerates innovation, driving down the cost while upping the supply of clean energy. The result: abundant, ever-cheaper clean energy, more of it faster. Plus a boost to GDP from the tax rate cut and cheaper energy.

Imagine if farmers, ranchers, or ordinary investors, maybe you or me, could keep 90% of all profits on wind farms, up from the usual 65% or less, as a fair reward for safeguarding the future. How many wind farms would be built?

Taxes, Growth, and Economics

Although clean tech tax rate cuts is a new policy option needing much study, we already know it should work, because many influential economists, leaning Republican or Democrat, conclude tax changes (especially, some say, tax rate changes) have a significant impact on growth. Tax policy often reflects that basic understanding. Tax increases, such as the carbon tax, have been proposed to reverse the growth in fossil fuels. Marginal tax rate cuts have been used frequently to promote growth, notably under presidents Kennedy, Johnson, and Reagan.

You know there is some sort of high level bi-partisan agreement on this basic point when you read the former Chair of Bush’s Council of Economic Advisors, Harvard Professor Greg Mankiw approvingly citing research of former Chair of Obama’s Council of Economic Advisors, Berkeley Professor Christina Romer: “[R]ecent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars.” The Romer study also finds that every $1 of tax cut raises private investment by $11. That is eleven times the bang for the buck compared to the government spending $11 directly.[5]

The Romers’ conclusions are broadly in line with that of Mankiw’s Harvard colleague, Robert Barro, one of the most cited and influential living economists. Barro finds that cuts to marginal tax rates are superior to government spending in promoting growth. Barro writes: “a cut in the average marginal tax rate by one percentage point raises next year’s per capita GDP by around 0.5%.”[6] So, to put that in perspective, a 10 percentage point cut in average marginal tax rates might be expected to raise the economic growth rate 5 percentage points the following year.

Mankiw, in his own work, finds that capital tax cuts are among the cheapest ways to promote growth, noting that “half of a capital tax cut is self-financing” compared to broad based tax cuts on capital and labor, which are 25% self financing.[7] Of particular relevance to Clean Tech Tax Rate Cuts, is another Mankiw observation: “Tax relief is good for growth, but only if the tax reductions are financed by spending restraint. One exception: Lower taxes on dividends and capital gains promote growth, even if they require higher income taxes.”

So, if Mankiw is correct, to the extent Clean Tech Tax Rate Cuts can replace spending on subsidies and regulation, they will be particularly effective at producing growth. And to the extent they target dividend and capital gains taxes, they will be even more extremely effective at promoting growth, even if they do not cut spending on subsidies or regulation right away.[8]

Fortunately the prospect for replacing subsidies and regulation is excellent, as I will explain shortly.

The Golden Opportunity that is Climate Hysteria

If it is true that economy-wide corporate income, dividend and capital gains tax rate cuts would have a beneficial effect on GDP, as many believe, then it is highly likely that such tax rate cuts on even just part of the economy would also have a beneficial effect on GDP.

In other words, to translate this from economics to politics, even if conservatives do not have the political muscle to get the across-the-board tax cuts they ideally want, fear of climate change gives conservatives a golden opportunity to get the same kind of tax rate cuts on a major and fast growing portion of the new economy, with a similar boost to GDP, and lower energy prices to boot. We can’t get those kinds of tax cuts on banking, for instance. But we can get them on the highly entrepreneurial clean tech sector. With great side benefits too: subsidies, regulations, spending and big government, all reduced, and so too all kinds of environmental and health damages, quite apart from climate change.

The political benefits of doing so go beyond a boost to GDP. Offering a genuine, pro-capitalist, free market solution to climate change is most statesman-like, ends gridlock, and restores civility to a pointlessly acrimonious issue. It would help heal American politics, restoring to conservatism the lost knack for new ideas and genial optimism, once deployed with élan by leaders like Ronald Reagan, who doubtless learned it from both Roosevelts.

Indeed, just as England, fighting alone through two grim years, 1939 – 1941, longed for FDR’s reluctant but capable Yanks to join the battle against Hitler, moderates and progressives would welcome anything that can inspire conservatives to join the battle against climate change. Should conservatives offer a new, optimistic free market consensus solution to climate change, that welcome event would draw progressives and moderates closer towards a general free market consensus, away from left fringe extremists and ideologues, and set the stage for a new global appreciation for the power of clean capitalism — of low capital tax rates and positive side free market deregulation — to promote growth and prosperity around the world, without bad side effects.

If you are a conservative, you don’t even need to care about climate change to see a couple of dozen benefits to this strategy. But of course, these days, even Charles Koch says CO2 linked climate change is real. So if climate change is an actual risk, all the more reason to take some action that will not harm the economy, but will only help.

Reality Check: Why do we need to do anything?

A smart, free market economist I know, when presented with the new LCOE market data (see Part I), asked me: “Assuming your facts on alternative energy are correct, then why is any policy necessary? If solar and wind are already cheaper than coal or gas, then no additional incentives are necessary for people to invest in developing these technologies (there are $100 bills laying on the ground for the taking — in fact $100 bills that the government wants people to take).”

Well, it should be said, the facts do not show that “solar and wind are already cheaper than coal or gas,” not across the entire industry, only at the leading edge, comparing best executed and sited projects. The competition is on, but not won. The trend is what matters, and tax rate cuts can accelerate those market drivers, reducing clean energy costs, and boosting supply, even faster.

But still, a good question. One that deserves its own future column. IPCC renewable energy targets and scenarios get complicated fast, requiring phonebook-sized reports to explain, and clean capitalists can definitely do MORE unassisted than experts have forecast.

But one short answer is, even with capitalist market magic in the air and sunshine, and even with all the policy support that exists now, most climate experts believe that renewables, and all the other clean tech solutions they hope will emerge, will need even more policy support than they are getting right now in order to bring down CO2 levels fast enough to keep climate catastrophe at bay. Take a look at this chart from the International Energy Agency (IEA):

The 2015 -2020 stacks shows projected renewable power net additions under current policy as of mid-2015. The green line shows a 25% higher level of additions, the amount the IEA recommends “to limit the long-term global average temperature increase to 2°C” only possible with increased policy support on top of existing policy support. Clean tech tax rate cuts could help close that gap, eliminating the need for more regulation or subsidies.

One further reason to boost fast growing technologies like big wind as solar as much as (profitably) possible — even if they seem to be on track without support — is that other technologies the IPCC is counting on to bring down carbon emissions, like carbon capture and storage (CCS) may not pan out as expected. So it is only prudent to drop any tax or regulatory barriers inhibiting the clean technologies that market forces have picked as winners, as these may need to make up any gap left by the disappointments. And cutting such taxes will not hurt the economy.

Oh, yes! Almost forgot. There is another short answer, one especially for conservatives who have doubts about climate change. Why clean tech tax rate cuts?

It’s a tax cut.

It raises prosperity and cuts energy costs economy-wide. As uber capitalist economist Milton Friedman once said: “I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible.” Good advice from Uncle Milton.

No question, subsidies and regulation have both helped wind and solar scale up to the point they are now, on the threshold of unsubsidized competitive profitability. Yes, big solar and wind will, from here on, definitely show strong growth without subsidies or mandates or carbon taxes or tax rate cuts. But they will grow much faster with supportive policies.

GMT Research projections from last year show solar industry growth with and without subsidy from the 30% federal Investment Tax Credit (ITC). The solar industry will thrive and grow without the ITC… but it grows much faster with the subsidy (and even that is not fast enough for climate experts):

But subsidies are a two-edged sword. They have serious drawbacks that undermine the very industries they seek to promote. Since subsidies support some companies that would otherwise fail, they promote failure and dependency. Since the survival of industry laggards depend on continuing the policy, some governments that go down this road in a big way create extremely dangerous economic bubbles which can collapse and do great harm if ever the subsidy money disappears.

This is exactly what happened in Europe in 2009 – 2013, in the wake of the global financial meltdown, especially so in the most heavily subsidized countries like Spain, where crushing unemployment topped out at over 26% when the subsidy bubble burst. Subsidy dependence can actually scare off investors and depress or wreck markets.

The good news is, the best clean capitalists have learned this lesson.

In 2011, heavily subsidy-dependent industry leader First Solar saw its stock price crash, along with the rest of the industry, as worldwide recession caused European governments to cancel or scale back solar subsidy programs. First Solar found itself roundly mocked in the financial press as dependent on subsidies for profit.

But First Solar got the message. Since 2011, First Solar core strategy has been to diversify specifically into unsubsidized markets, and focus on driving down costs. Last year, Motley Fool analysts noted that, precisely because of its diversification into unsubsidized markets and cost leadership, First Solar was the the best position of any company to gain more market share EITHER in the event of the termination of the ITC, or if, as it turned out, the ITC was extended. Weaning itself away from subsidy dependence has been key to First Solar’s current market leadership and high regard among investors and analysts.

First Solar is showing the rest of the industry how to take off the training wheels. By contrast, and driving home the point, markets also punish companies that remain dependent on subsidy-fueled growth, like SolarCity or SunEdison. That too is part of the capitalist process — creative destruction — where weak business models falter to make way for stronger strategies, usually low cost, high profit market leaders.

Capitalism is not for wimps.

So, three reasons clean tech tax rate cuts could replace subsides very soon: (1) industry leaders recognize the problem that subsidies undermine the value of their industry; (2) big wind and solar are fast becoming competitive on unsubsidized price alone, so that justification for subsidies is disappearing fast; and (3) if policy support is necessary, tax rate cuts have a more powerful growth effect, for less money, and especially without the failure promotion problem:

No way, no how, can tax rate cuts can be used to promote failure, dependence, or dangerous subsidy bubbles. Unprofitable businesses get no benefit from a tax cut on profits. Only profitable businesses benefit from a tax rate cut. The most profitable ones benefit the most.

This is key to understanding the acceleration effect of tax cuts, and why tax rate cuts are the opposite of subsidies, in that they promote success, not failure. The more profitable the business, the more money they keep and have to invest as a result of the tax cut. This makes them even more attractive to new investors relative to the competition. So they get the most new investment, more than they would have otherwise, and can accelerate their growth rate faster. What is more, the tax cut and larger profits gives them extra room to drop their prices, more than the competition. So the most successful firms get promoted the fastest as a result of tax cuts, and prices drop faster than otherwise possible. Much more efficient than subsidies… Tax rate cuts really are rocket fuel for low cost market leaders.

And if the tax rate cut goes away? Slower growth, but no market collapse. Without subsidies to start with, any existing companies benefiting from the tax rate cut would be, by definition, profitable, and so not dependent. This tendency of tax cuts to promote sustainable success will in turn foster a healthy market for clean investment. That is exactly what clean investors and entrepreneurs need to attract more investment and grow companies.

So there is good reason to believe clean tech tax rate cuts will be preferred over subsidies. The same is true for mandates and regulation.

To the degree costs are driven down, regulations become irrelevant, because the shift to cleaner technology becomes driven by price alone. We can see this is already happening as a result of the recent cost reductions. GMT Research notes: “Moving forward, RPS mandates will not be as a big a driver for renewable adoption as they had been in the past… The shift away from a reliance on RPS mandates to deploy renewables is already underway. In 2013, 71 percent of renewable energy installments were due to RPS requirements, a figure that dropped to 46 percent in 2015.”

The Importance of Staying Positive

But perhaps the biggest reason Clean Tech Tax Rate Cuts might well prove popular is that, for many folks, existing climate policies all just come across as negative, as in anti-capitalist, anti-business, mean-spirited… and this rubs many Americans the wrong way.

Every climate policy in use today either increases taxes and energy prices (carbon tax) or spending and government power (subsidies, mandates, the Clean Power Plan); all create economic drag, as well as burdens on taxpayers or businesses. They can hurt the economy, and sometimes are intended to kill whole industries. They smack of a big government agenda, cronyism, and a desire to punish the bad guy, whoever that is. So they generate opposition from conservatives, anyone in the fossil fuel industry, developing nations, and many ordinary folks, often moderates, who smell the punitive ideology and simply don’t want to see their energy prices go through the roof or the economy tank. Gridlock ensues.

By contrast, clean tech tax rate cuts don’t punish anybody, and reduce all harm. They cut taxes, and don’t raise them. They drive down energy prices, and don’t hike them. They boost the GDP, rather than shrink it. They empower entrepreneurs, and demonize no one. They clean up the environment and help save the planet. They cut spending and shrink the size of government. They replace, punitive, expensive, economically harmful big government policies with an all-positive tax cut.

Positive Side Tax Cuts?

Clean Tax Rate Cuts are all carrot, no stick. All positive, they act entirely on the positive side, reducing burdens and accelerating growth for industries that have positive externalities (econo-jargon for good side effects) that can reduce the risks posed by industries with potentially disastrous negative externalities (bad side effects) in this case, fossil fuels. So you could call them a kind of positive side tax cut.

Industries with large negative side effects, like fossil fuels, otherwise have an unfair advantage in the market because they avoid the full cost of the many problems they create: from massive oil spills and railway disasters, to groundwater contamination; from ocean acidification and mass extinction, to regional and worldwide toxic health effects; from mercury-related brain damage in newborns, to asthma, to COPD and cancer; from frack quakes to the risk of climate disaster. (And that is the short list.)

Positive side tax rate cuts simply boost the positive, which levels the playing field, but does not punish or burden anyone, not even industries with negative externalities. It merely gives investors and companies a GDP-boosting incentive to diversify into profitable clean tech alternatives. Nobody is the bad guy here, no one should be punished… but maybe everyone, the whole economy, could use some help becoming more positive.

The Double-Negative of a Carbon Tax: A No-Carbon Tax Cut

It is interesting to note that positive side Clean Tax Rate Cuts are essentially the double-negative of the carbon tax: a no-carbon tax cut. Carbon taxes act as a negative force, suppressing industries with the negative side effects, while Clean Tax Rate Cuts act as a positive side force, boosting industries with positive side effects.

Carbon taxes are an example of what economists call pigouvian taxes, after the British economist Arthur Pigou who first identified the problem of negative externalities. He proposed a tax on negative externalities as one way to potentially solve the problem of bad side effects burdening the public and the taxpayer, to end a free ride at the public expense.

Some economists consider pigouvian taxes the most direct and efficient way of dealing with negative externalities. Not all agree. The great irony of taxes meant to curb bad side effects is that they have negative side effects themselves. Higher taxes depress the economy. Carbon taxes doubly so, because the tax has a depressive effect itself, but also makes energy prices higher, which further depresses GDP. As skeptical environmentalist Bjorn Lomborg explained recently: “Trying to cut carbon dioxide, even with an efficient carbon tax, will make cheap energy more expensive — and this will slow economic growth.”

Poor folks especially are hit hard. Anyone whose business involves transportation or fossil fuel energy gets poorer. Needless to say, the entire purpose of the carbon tax is to kill off whole industries, which has the very bad side effect of destroying prosperity for millions of people, families, children, small businesses dependent on those industries. So carbon taxes develop one more fatal side effect: huge and insurmountable political opposition.[9]

All of these bad side effects can be avoided by staying positive.

Positive side tax rate cuts are an alternative to pigouvian taxes. Both level the playing field, both “price” the negative and positive externalities. The key differences being that positive side policy (1) does it all on the positive side, to avoid inevitable negative side effects involved in going negative; and (2) focuses on investment tax rates, rather than just sales taxes or pigouvian subsidies, because that is the soundest and most cost-effective way to promote growth on the positive side, if profits are in sight.

As the negative side approach has negative side effects, it should be no surprise, perhaps, that the all-positive approach itself has a long list of positive side effects, the most surprising being:

Climate Change Doesn’t Matter Anymore

Clean tax rate cuts can help cure climate change, but you don’t have to care about climate change to like clean tax rate cuts. It is enough to like cheap, clean energy, and prosperity. Positive side tax cuts are a net benefit to both the economy and the environment, without any harmful side effects. What’s not to like?

So if you want to make progress on reducing tax rates, or you want to get rid of bad big government policies, or you want to boost GDP and accelerate prosperity, if you want cheaper, cleaner energy, if you want America to have the competitive advantage in the energy markets of the 21st century, then clean tech tax rate cuts looks like a pretty good option, whether you worry about climate change or not. If you like clean water and air and good health… If you want to reduce smog, oil spills, toxic air and groundwater pollution, cancer, birth defects, asthma, COPD, ocean acidification, mass extinctions, etcetera, then Clean Tax Rate Cuts are a pretty good way to get there, with a profit to boot.

But for conservatives and free market advocates, there is more.

If we want conservatism and capitalism to receive due credit for a genuine breakthrough, ending partisan acrimony and gridlock, saving the planet, accelerating key market trends we can see right now, clean tax rate cuts is the right policy. Climate change is a global issue. So if we want to expand the global popularity of low tax and free market policy alternatives, this is a rare moment of opportunity, since this issue impacts every nation on the planet. If we can lead the way with a truly effective free market policy option on climate, energy, and prosperity, this is the sweet spot to win over moderates and progressives globally to a greater appreciation of the potential of capitalism to deliver prosperity without bad side effects.

This could be an easy win-win, delivering clear benefits to both conservatives and progressives, and all free market moderates in between.

We have long been told climate change was part of a hoax to usher in socialist policies and regimes, or if not a hoax, that expensive big government policies were the only possible solution.

In fact, fear of climate disaster is God’s gift to conservatives, a golden opportunity to spark a new world-wide recognition of the power of clean capitalism — of low capital tax rates and positive side free market deregulation — to promote growth and prosperity around the world, without bad side effects, and for a profit.

If we stay on the positive side, capitalism can and will save the planet.

[2] Prof. Steven Cohen, Executive Director of Columbia University’s Earth Institute, is a rare exception. In an article last June, Prof. Cohen called for, among other measures, “reduced corporate taxes” on “advance renewable energy, energy efficiency and energy storage technologies,” in order to “to lower the price of renewable energy,” which he argued should be the focus of climate policy.

[3] Of course, further study is warranted into any promising new policy or specific application.

[5] Christina D. Romer & David H. Romer, 2010. “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks,” American Economic Review, American Economic Association, vol. 100(3), pages 763-801, June. While the study looks at all tax changes, not specifically marginal rate cuts to corporate and capital gains taxes, the Romers’ 1:3 tax multiplier is based upon a study of post-WWII exogenous tax changes (such as the Kennedy, Reagan and Bush tax cuts, or the Clinton tax hike) which are actually heavily weighted to marginal tax rate changes. So the part of their results I am citing (multipliers based on exogenous tax changes), would still be strongly suggestive concerning the impact of marginal rate cuts to corporate or capital gains taxes. Suggestive is pretty much all we can hope for, so this still looks like pretty good support for the proposition that clean tech tax rate cuts would have a positive growth effect.

[8] The growth effect from Clean Tech Tax Rate Cuts is likely to be stronger than the kinds of economy-wide growth effects these macro economists measure, because these are asymmetrical tax rate cuts. Clean tech tax rates would be lower than for the rest of the economy, to value critical positive externalities properly.

[9] To cure these problems, carbon tax advocates always have a part 2 to their proposal: what will be done with the revenue? Some propose public dividends, some propose various tax cuts, others say spend the money on more clean tech subsidies, some say pay down the public debt, or boost spending on favorite causes. In other words, the carbon tax rapidly morphs from a simple solution into a very complex one, with great disagreement on what part 2 of the policy should actually be.

A carbon tax may well be effective medicine, but it violates a key principle of bioethics: “First, do no harm.” Perhaps a precept that should apply to economics. A pigouvian carbon tax does create harm, as a side effect to the cure, and there is no guarantee that the mist-mash of part 2 proposals on display will eliminate that harm. I note that positive side clean tech tax rate cuts, which make a point to “first, do no harm” with primary policy, would do a great deal to eliminate part of the harm of a carbon tax, by offering a boost to the GDP and lowering energy prices. Indeed there is no doubt that a carbon tax plus clean tech tax rate cuts, acting together, would be twice a effective as either alone in curbing harmful emissions, with less harm than a carbon tax alone. However, if that double-barrel effect is not after all necessary, is is easy to see why an all positive policy might come to be preferred as an alternative. Especially in certain situations of stiff political opposition to the carbon tax, or where there are pressing concerns about avoiding poverty.